Risks Still Elevated At These Prices As Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) Shares Dive 26%

Aarey Drugs & Pharmaceuticals Limited (NSE:AAREYDRUGS) shares have had a horrible month, losing 26% after a relatively good period beforehand. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 17%.

Even after such a large drop in price, Aarey Drugs & Pharmaceuticals' price-to-earnings (or "P/E") ratio of 56.8x might still make it look like a strong sell right now compared to the market in India, where around half of the companies have P/E ratios below 25x and even P/E's below 14x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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For instance, Aarey Drugs & Pharmaceuticals' receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Aarey Drugs & Pharmaceuticals

Although there are no analyst estimates available for Aarey Drugs & Pharmaceuticals, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Aarey Drugs & Pharmaceuticals' Growth Trending?

In order to justify its P/E ratio, Aarey Drugs & Pharmaceuticals would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 44% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 22% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 25% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Aarey Drugs & Pharmaceuticals is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Aarey Drugs & Pharmaceuticals' P/E

Aarey Drugs & Pharmaceuticals' shares may have retreated, but its P/E is still flying high. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Aarey Drugs & Pharmaceuticals revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Aarey Drugs & Pharmaceuticals (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

Of course, you might also be able to find a better stock than Aarey Drugs & Pharmaceuticals. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.